DeFi and Crypto Cannot Sustain Under US Senators’ Crypto Tax Proposal

• US Senators propose 1099-B reporting for crypto taxes.
• Cryptos’ decentralization poses challenges for cost basis reporting.
• Experienced crypto analysts call for rules to suit crypto’s unique nature.

Elizabeth Warren and other senators have recently called for the implementation of 1099-B reporting for crypto transactions. They believe this will address the perceived ‘$50 billion’ tax gap. However, experts in the crypto tax space argue that this approach is impractical. Specifically, the move may lead to significant challenges for crypto users.

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In detail, form 1099-B is an information reporting system used to report capital gains and losses from securities transactions. However, it is a system used in the world of traditional finance. The proposed extension of 1099-B reporting to crypto exchanges is seen as a way to enhance tax compliance for crypto.

According to a discussion on the Reddit thread CryptoCurrency, there is a major flaw in this plan. In particular, this user says this approach lies in the fundamental differences between cryptos and traditional equities. 

To highlight, the crypto analysis says cryptos are built on blockchain technology. This enables interoperability and peer-to-peer transfers without the need for third-parties. While this decentralized feature brings immense benefits, it also poses a problem for 1099-B reporting.

Unlike traditional equities, where brokers hold deep cost basis information for securities transactions, crypto exchanges often lack such data. With millions of wallet to wallet transfers happening daily, exchanges may not have access to the original cost basis for cryptos moved from user wallets.

For instance, if a user buys 1 Bitcoin for $20,000 on Exchange A, transfers it to a self-custodied wallet, and later sells it for $50,000 on Exchange B, the latter would have no knowledge of the user’s initial cost basis. As a result, 1099-B reporting by Exchange B would lack critical cost basis information, likely leading to flawed tax reporting and tax burdens for users.

Moreover, the nature of cryptos and dApps makes it challenging to impose reporting requirements akin to traditional equities brokers. The crypto ecosystem consists of numerous decentralized wallets, protocols, and NFT marketplaces, and not all players have the capacity to pass along or store sensitive customer data for reporting purposes.

Instead of implementing 1099-B reporting, the analyst suggests developing new, more sensible rules specifically tailored to the unique characteristics of cryptos and digital assets. By recognizing and addressing the interoperability of blockchains, regulators can work towards more effective tax reporting solutions that align with the decentralized nature of cryptos.

While the intentions behind the proposed 1099-B reporting for cryptos may be well-meaning, it is clear that a one-size-fits-all approach from the traditional financial world may not be suitable for the rapidly evolving and decentralized landscape of cryptos. 

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